The Tell: U.S. dollar set to face more pain in 2018, so here’s how to prepare, says Wells Fargo

After a protracted period of weakness, should those investors maintaining a bullish outlook on the U.S. dollar throw in the towel? A Wells Fargo strategist in a Tuesday research note makes the case that it may be time to give up the ghost, with more pain for dollar bulls in the offing, even if the bank doesn’t think that the buck will lose its global-currency status.

“The U.S. dollar is the most widely used and most easily obtained currency in the world,” wrote Austin Pickle, investment strategy analyst at the bank. “It is not in imminent danger of losing that status. Yet the dollar’s importance does not equate to strength.”

The dollar’s downturn, as measured by the ICE U.S. Dollar Index DXY, -0.27% has gathered momentum since its last peak in late 2016, but over a longer stretch, say 50 years, the greenback has actually steadily trended lower, Pickle said, warning that investors should take heed of this protracted weakening trend.

Why? Because that downdraft isn’t likely to be halted by Federal Reserve interest-rate hikes, the end of easy-money policies by other central banks, or further fiscal stimulus in the U.S.

“Our forecast is for continued dollar depreciation at least for the remainder of 2018. Heavier U.S. government borrowing, a broad-based international economic recovery, and the forthcoming end to the European Central Bank’s accommodative history of past cycles repeats itself, or even rhymes, we may be faced with a weak dollar for years beyond 2018.”

What should investors do to guard against a downbeat dollar? Diversification is key, says Wells Fargo.

“U.S.-dollar-denominated allocations to international developed- and emerging-market equities are two of the simplest -— and most effective — ways to insulate a portfolio from a declining dollar,” the bank’s analyst wrote.

“In dollar terms, international [developed market] stocks have consistently outperformed domestic stocks when the dollar depreciates — and vice versa,” Wells Fargo said. The chart above shows the dollar’s performance (in blue), compared against that of equity benchmarks of developed countries (in orange), as gauged by the iShares MSCI ACWI ex US ETF ACWX, -0.81%

Similarly, emerging-market stocks (see chart below), as measured by the iShares MSCI Emerging Markets ETF EEM, -0.90% have also outperformed domestic U.S. stocks in dollar terms, the Wells Fargo report indicated.

Global stocks have proven to be a more consistent dollar hedge than gold GCJ8, +0.45% which is considered a traditional hedging asset, Pickle wrote, citing the 1980s dollar bear-market, for example, in which gold failed to buffer investors against a downtrodden greenback.

“In addition, commodities are struggling with their own bear super-cycle, and we have an unfavorable near-term outlook on gold, and other commodities in general,” Pickle said, arguing that gold prices, which closed at $1,327.10 an ounce on Tuesday, its highest level in about a week, are set to finish 2018 in negative territory.

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